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Foreign Exchange

EU watchdog warns on potential for regulatory arbitrage in FX derivatives

The problem of international regulatory inconsistency for FX derivatives that are not centrally cleared is more serious than the debate about whether they should have an exemption from clearing, says the European Securities and Markets Authority (ESMA), the EU’s financial regulator.

Steven Maijoor, chairman of ESMA, told a conference in London on Wednesday that while many industry representatives had battled for an exemption from clearing obligations for FX derivatives – such as options and non-deliverable forwards – the potential for the US and Europe to treat the products differently was his greatest cause for concern. “The real issue on FX derivatives that only a few have spotted is not the clearing obligation but the bilateral collateralisation,” he said.

“The problem of international inconsistency and regulatory arbitrage is much more serious on margins for contracts that are not centrally cleared than on the clearing obligation.”

Maijoor said that, in the US, FX derivatives are fully exempted from the application of the Dodd-Frank Act. Therefore, the margin requirements for non-centrally cleared transactions would not apply. However, they will apply in the European Union, he said.

“Let me be clear, I am not calling for a similar exemption,” he added. “The European approach is consistent because it looks at the overall risks of derivatives markets and at all the market players.

“However, it should be recalled that we have a common objective established by the G20 and the introduction of significant local exceptions risk compromising the global picture.”

Maijoor declined to discuss whether the clearing obligation should or should not apply to FX derivatives.

“Any conclusion on that is simply too premature considering the many aspects that ESMA needs to take into account before applying the clearing obligation to any class of derivatives,” he said.

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